Budgeting for Planning

and Control
Topic 1

8-1
 Budget

 The quantitative expression of a proposed plan of

action by management for a specified period
 An aid to coordinating what needs to be done to
implement that plan
 Budgets can be used to compare actual outcomes
with planned outcomes

8-2
 Planning:

Strategic Plan
The Master Budget
and Its
Long-Term Interrelationships
Objectives
F
e Short-Term Control:
e Objectives
d Compare actual results
b with planned amounts
a Budgets
c
k Operations

Production,
Service, and Sales
8-3
 Purposes of Budgeting
1. It forces managers to plan.
2. It provides resource information that can be
used to improve decision making.
3. It provides a standard for performance
evaluation.
4. It improves communication and
coordination.

8-4
 Directing and Coordinating the
Budgets
Budget Director: works under the direction of the budget
committee; usually the controller or someone who reports
to the controller.

Budget Committee: responsible for reviewing the budget,

providing policy guidelines and budgetary goals, resolving
differences that may arise as the budget is prepared,
approving the final budget, and monitoring the actual
performance of the organization.

8-5

8-5
Two Dimensions of Budgeting

1. How is the budget

prepared?
2. How is the budget
used to implement the
organization’s plan?

8-6
 Master Budget

 A comprehensive financial plan made up of

various individual departmental and activity
budgets for the year.
 Components of master budget:
• Operating budgets are concerned with income
generating activities
• Financial budgets are concerned with inflows and
outflows of cash and with financial position

8-7
The Role of Budgeting in Planning
and Control
 The data used to create the budget come from many
sources.
 The sales forecast is the basis for the sales budget –
which is the basis for all of the other operating
budgets and most of the financial budgets.
 A continuous or rolling budget is a moving twelve
month budget.

8-8 8-8
Preparing the Operating Budget
1. Sales budget
2. Production budget
3. Direct materials purchases budget
4. Direct labor budget
5. Overhead budget
6. Ending finished goods inventory budget
7. Cost of goods sold budget
8. Marketing expense budget
9. Research and development budget
10. Administrative expense budget
11. Budgeted income statement
8-9
 Schedule 1 (in thousands)
ABT, Inc.
Sales Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Units 2,000 6,000 6,000 2,000 16,000
Unit selling price x $0.70 x $0.70 x $0.80 x $0.80 x $0.75
Sales $ 1,400 $ 4,200 $ 4,800 $ 1,600 $12,000

The sales forecast is the basis for the sales budget.

The accuracy of the sales forecast strongly affects the
soundness of the entire master budget.
8-10
 Computing Units to be Produced

Units to be produced = Expected unit sales +

Units, ending inventory
– Units, beginning
inventory

8-11
 Schedule 2 (in thousands)
ABT, Inc.
Production Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Sales (Schedule 1) 2,000 6,000 6,000 2,000 16,000
Desired ending
inventory 500 500 100 100 100
Total needs 2,500 6,500 6,100 2,100 16,100
Less: Beginning
inventory 100 500 500 100 100
Units to be produced 2,400 6,000 5,600 2,000 16,000

8-12
 Schedule 3 (in thousands)
ABT, Inc.
Direct Materials Purchases Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Units to be produced
(Schedule 2) 2,400 6,000 5,600 2,000 16,000
Direct materials per
unit (lbs.) x 26 x 26 x 26 x 26 x 26
Production needs 62,400 156,000 145,600 52,000 416,000
Desired ending
inventory (lbs.) 8,000 8,000 5,000 5,000 5,000
Total needs 70,400 164,000 150,600 57,000 421,000

Continued
8-13
 Quarter
1 2 3 4 Year
Total needs 70,400 164,000 150,600 57,000 421,000
Less beginning
inventory 5,000 8,000 8,000 5,000 5,000
Direct materials to
be purchased (lbs.) 65,400 156,000 142,600 52,000 416,000
Cost per pound x $0.01 x $0.01 x $0.01 x $0.01 x $0.01
Total purchase
cost $ 654 $ 1,560 $ 1,426 $ 520 $ 4,160

8-14
 Schedule 4 (in thousands)
ABT, Inc.
Direct Labor Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Units to be produced
(Schedule 2) 2,400 6,000 5,600 2,000 16,000
Direct labor time
per unit (hrs.) x 0.015 x 0.015 x 0.015 x 0.015 x 0.015
Total hours needed 36 90 84 30 240
Wage per hour x $8 x $8 x $8 x $8 x $8
Total direct labor
cost $ 288 $ 720 $ 672 $ 240 $ 1,920

8-15
 Schedule 5 (in thousands)
ABT, Inc.
Overhead Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Budgeted direct labor
hours (Schedule 4) 36 90 84 30 240
Variable overhead
rate x $8 x $8 x $8 x $8 x $8
Budgeted variable
overhead $288 $ 720 $672 $240 $1,920
Budgeted fixed
overhead 320 320 320 320 1,280
Total overhead $608 $1,040 $992 $560 $3,200

8-16
 Schedule 6 (in thousands)
ABT, Inc.
Ending Finished Goods Inventory Budget
For the Year Ended December 31, 20X6
Unit-cost computation:
Direct materials (26 lbs. @ $0.01) $0.26
Direct labor (0.015 hr. @ $8) 0.12
Overhead:
Variable (0.015 hr. @ $8) 0.12
Fixed (0.015 hr. @ $5.33) 0.08
Total unit cost $0.58
Units Unit Cost Total
Finished goods: Concrete blocks 100 $0.58 $58

8-17
 Schedule 7 (in thousands)
ABT, Inc.
Cost of Goods Sold Budget
For the Year Ended December 31, 20X6
Direct materials used (Schedule 3) $4,160
Direct labor used (Schedule 4) 1,920
Overhead (Schedule 5) 3,200
Budgeted manufacturing costs $9,280
Beginning finished goods 55
Goods available for sale $9,335
Less: Ending finished goods (Schedule 6) 58
Budgeted cost of goods sold $9,277

8-18
 Schedule 8 (in thousands)
ABT, Inc.
Marketing Expense Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Planned sales in units
(Schedule 1) 2,000 6,000 6,000 2,000 16,000
Variable marketing
expenses per unit x$0.05 x$0.05 x$0.05 x$0.05 x$0.05
Total variable
expenses $ 100 $ 300 $ 300 $ 100 $ 800

Continued
8-19
 Quarter
1 2 3 4 Year

Fixed marketing
expenses:
Salaries $ 10 $ 10 $ 10 $ 10 $ 40
Advertising 10 10 10 10 40
Depreciation 5 5 5 5 20
Travel 3 3 3 3 12
Total fixed expenses $ 28 $ 28 $ 28 $ 28 $112
Total marketing
expenses $128 $328 $328 $128 $912

8-20
 Schedule 9 (in thousands)
ABT, Inc.
Research and Development Expenses Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Sales $18 $18 $18 $18 $ 72
Prototype design and
development 10 10 10 10 40
Total R & D
expenses $28 $28 $28 $28 $112

8-21
 Schedule 10 (in thousands)
ABT, Inc.
Administrative Expense Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Salaries $25 $25 $25 $25 $100
Insurance --- --- 15 --- 15
Depreciation 10 10 10 10 40
Travel 2 2 2 2 8
Total administrative
expenses $37 $37 $52 $37 $163

8-22
 Schedule 11 (in thousands)
ABT, Inc.
Cost of Goods Sold Budget
For the Year Ended December 31, 20X6
Sales (Schedule 1) $12,000
Less: Cost of goods sold (Schedule 7) 9,277
Gross margin $ 2,723
Less: Marketing expenses (Schedule 8) -912
R & D expenses (Schedule 9) -112
Administrative expenses (Schedule 10) -163
Operating income $ 1,536
Less: Interest expense (Schedule 12) 42
Income before taxes $ 1,494
Less: Income taxes 600
Net income $ 894

8-23
 Schedule 11 (in thousands)
ABT, Inc.
Cost of Goods Sold Budget
For the Year Ended December 31, 20X6
Sales (Schedule 1) $12,000
Less: Cost of goods sold (Schedule 7) 9,277
Gross margin $ 2,723
Less: Marketing expenses (Schedule 8) -912
R & D expenses (Schedule 9) -112
Administrative expenses (Schedule 10) -163
Operating income $ 1,536
Less: Interest expense (Schedule 12) 42
Income before taxes $ 1,494
Less: Income taxes 600
Net income $ 894
8-24
 The Financial Budgets

• Capital expenditures budget – financial plan

outlining the expected acquisition of long term
assets.
• Cash Budget – detailed plan that shows all expected
sources and uses of cash
• Budgeted balance sheet – represents the
culmination of the financial events of the coming
year and shows management where the company is
expected to be at the end of the year
• Budgeted statement of cash flows 8-25
 The Cash Budget
Beginning cash balance
+ Cash receipts
Cash available
- Cash disbursements
- Minimum cash balance
Excess or deficiency of cash
- Repayments
+ Loans
+ Minimum cash balance
Ending cash balance
8-26
 Additional Information

 Min cash balance = $100,000 for the end of each Q. Beginning cash balance =
$120,000
 Money can be borrowed & repaid in multiples of $100,000. Interest = 12%
per year. Interest payment are made only for the amount of the principal
being repaid. All borrowing takes place at the beginning of a Q & repayment
takes place at the end of a Q.
 ½ of all sales = cash, ½ are on credit; 70% are collected in the Q of sales &
30% are collected in the following Q. Sales for last year (4th Q) = $2million.
 Purchases of materials = on account; 80% are paid for in the Q, 20% in the
following Q. Last year purchases = $500,000
 Budgeted depreciation = $200,000 per Q for OH.
 Buying new equipment $600,000 in 1st Q for OH & 10% depreciation rate per
year.
 Income taxes = $600,000 & will be paid at the end of 4th Q.

8-27
 Schedule 12 (in thousands)
ABT, Inc.
Cash Budget
For the Year Ended December 31, 20X6
Quarter
1 2 3 4 Year
Beginning cash balance $ 120 $ 113 $ 152 $1,334 $ 120
Cash collections 1,490 3,780 4,710 2,080 12,060
Total cash available $1,610 $3,893 $4,862 $3,414 $12,180

Total disbursements $2,097 $3,317 $3,310 $2,079 $10,803

Minimum cash balance 100 100 100 100 100
Total cash needs $2,197 $3,417 $3,410 $2,179 $10,903

Excess (deficiency) of cash -$ 587 $ 476 $1,452 $1,235 $ 1,277

Add: Borrowings 600 --- --- --- 600
Less: Repayments --- 400 200 --- 600
Less: Interest paid --- 24 18 --- 42
Ending cash balance $ 13 $ 52 $1,234 $1,235 $ 1,235
Plus: Minimum cash balance 100 100 100 100 100
Ending cash balance $ 113 $ 152 $1,334 $1,335 $ 1,335

8-28
 Total Disbursements
ABT, Inc.
For the Year Ended December 31, 20X6

Quarter
1 2 3 4 Year

Material: current $ 523 $ 1248 $ 1141 $416 $ 3328

Prior 100 131 312 285 828
Direct labor 288 720 672 240 1920
Overhead 408 840 792 360 2400
Marketing 123 323 323 123 892
R&D 28 28 28 28 112
Admin 27 27 42 27 123
Income taxes - - - 600 600
Equipment 600 - - - 600

Total 2097 3317 3310 2079 10803

8-29
 ABT, Inc.
Schedule of Cash Receipts (in thousands)
Source Quarter 1 Quarter 2 Quarter 3 Quarter 4
Cash sales $ 700 $2,100 $2,400 $ 800
Received on
account from sales in:
Quarter 4, 2011 300
Quarter 1, 20X6 490 210
Quarter 2, 20X6 1,470 630
Quarter 3, 20X6 1,680 720
Quarter 4, 20X6 560
Total cash receipts $1,490 $3,780 $4,710 $2,080

8-30
 ABT, Inc.
Balance Sheet (in thousands)
December 31, 20X5
Assets
Current assets: Note that this is the
Cash actual balance sheet $ 120
Accounts receivable for 20X5 300
Material inventory 50
Finished goods inventory 55
Total current assets $ 525
Property, plant, and equipment:
Land $2,500
Building and equipment 9,000
Accumulated depreciation -4,500
Total property, plant, and equipment 7,000
Total assets $7,525
Continued
8-31
 Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable $ 100
Stockholders’ equity:
Common stock, no par $ 600
Retained earnings 6,825
Total stockholders’ equity 7,425
Total liabilities and stockholders’ equity $7,525

8-32
 Schedule 13 (in thousands)
ABT, Inc.
Budgeted Balance Sheet
December 31, 20X6
Assets
Current assets:
Cash $1,335
Accounts receivable 240
Material inventory 50
Finished goods inventory 58
Total current assets $1,683
Property, plant, and equipment:
Land $2,500
Building and equipment 9,600
Accumulated depreciation -5,360
Total property, plant, and equipment 6,740
Total assets $8,423
Continued
8-33
 Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable $ 104
Stockholders’ equity:
Common stock, no par $ 600
Retained earnings 7,719
Total stockholders’ equity 8,319
Total liabilities and stockholders’ equity $8,423

8-34
Static Budgets versus Flexible Budgets

 A static budget is a budget for a particular level of

activity.
A flexible budget is a budget that provides a firm with
the capability to compute expected costs for a range of
activity.

8-35
 The Uses of Flexible Budget
 The flexible budget can be used to prepare the budget
before the fact for the expected level of activity.
 Flexible budgeting can be used to compute what costs
should have been for the actual level of activity.
 Flexible budgeting can help managers deal with
uncertainty by allowing them to see the expected
outcomes for a range of activities.

8-36
 Flexible Production Budget
Variable Cost Range of Production (units)
Production Costs per Unit 1,000 1,200 1,400
Variable overhead:
Direct materials $4.00 $4,000 $4,800 $5,600
Direct labor 1.20 1,200 1,440 1,680
Variable overhead:
Supplies 0.45 450 540 630
Power 0.15 150 180 210
Total variable costs $5.80 $5,800 $6,960 $8,120
Fixed overhead:
Supervision $1,105 $1,105 $1,105
Depreciation 540 540 540
Total fixed costs $1,645 $1,645 $1,645
Total production costs $7,445 $8,605 $9,765

8-37
 Performance Report Quarterly
Production Costs
Actual Budget Variance
Units produced 1,200 1, 200 ----
Direct materials $4,830 $4,800 $30 U
Direct labor 1,440 1, 440 ----
Variable overhead:
Supplies 535 540 -5 F
Power 170 180 -10 F
Total variable costs $6,975 $6,960 $15 F

Continued
8-38
 Performance Report Quarterly
Production Costs
Actual Budget Variance
Units produced 1,200 1, 200 ----
Fixed overhead:
Supervision 1,055 1,105 -50 F
Depreciation 540 540 ---
Total fixed costs $1,595 $1,645 -$50 F
Total production costs $8,570 $8,605 $35 U

8-39
Behavior Dimensions of Budgeting
Goal congruence
Dysfunctional behavior
Frequent feedback on performance
Monetary and nonmonetary incentives
Participative budgeting
Realistic standards
Controllability of costs
Multiple measures of performance

8-40
Participative budgeting has three
potential problems:
1. Setting standards that are either too high
or too low.
2. Building slack into the budget.
3. Pseudoparticipation.

8-41
Incremental vs. Zero-based Budgeting

 Incremental Budgeting :

-- the budget process is concerned with the increment in

operations or expenditure for the coming budget period
 Zero-based Budgeting

--requires that all activities are justified and prioritized

before decisions are taken relating to amount of resources
allocated to each activity
--the projected expenditure for existing programs should
start from base zero

8-42
 Activity-Based Budgeting

Activity flexible
budgeting is the
prediction of what
activity costs will
be as activity
output changes.

8-43
Flexible Budget: Direct Labor Hours
Cost Formula Direct Labor Hours
Fixed Variable 10,000 20,000
Direct materials --- $10 $100,000 $200,000
Direct labor --- 8 80,000 160,000
Maintenance $ 20,000 3 50,000 80,000
Machining 15,000 1 25,000 35,000
Inspections 120,000 --- 120,000 120,000
Setups 50,000 --- 50,000 50,000
Purchasing 220,000 --- 220,000 220,000
Total $425,000 $22 $645,000 $865,000

8-44
 Activity Flexible Budget
Driver: Direct Labor Hours
Formula Level of Activity
Fixed Variable 10,000 20,000
Direct materials --- $10 $100,000 $200,000
Direct labor --- 8 80,000 160,000
Subtotal $0 $18 $180,000 $360,000

Driver: Machine Hours

Fixed Variable 8,000 16,000
Maintenance $20,000 $5.50 $64,000 $108,000
Machining 15,000 2.00 31,000 47,000
Subtotal $35,000 $7.50 $95,000 $155,000

Continued
8-45
 Activity Flexible Budget
Driver: Number of Setups
Fixed Variable 25 30
Inspections $80,000 $2,100 $132,500 $143,000
Setups --- 1,800 45,000 54,000
Subtotal $80,000 $3,900 $177,500 $197,000

Driver: Number of Orders

Fixed Variable 15,000 25,000
Purchasing $211,000 $ 1 $226,000 $236,000

Total $678,500 $948,000

8-46
Activity-Based Performance Report
Actual Costs Budgeted Costs Budget Variance
Direct materials $101,000 $100,000 $ 1,000 U
Direct labor 80,000 80,000 ---
Maintenance 55,000 64,000 9,000 F
Machining 29,000 31,000 2,000 F
Inspections 125,500 132,500 7,000 F
Setups 46,500 45,000 1,500 U
Purchasing 220,000 226,000 6,000 F
Total $657,000 $678,500 $21,500 F

8-47
Variances for the Inspection Activity
Activity Actual Cost Budgeted Cost Variance
Inspection:
Fixed $ 82,000 $ 80,000 $2,000 U
Variable 43,500 52,500 9,000 F
Total $125,500 $132,500 $7,000 F

8-48